The Following Is an Excerpt from a 2002 Press Release

question 61

Essay

The following is an excerpt from a 2002 press release by the US corporation, Pacific Gas and Electric (PG&E).
Accounting for PG&E NEG Synthetic Leases
The Corporation announced on Feb. 21 that it was initiating a thorough review of the accounting treatment of several synthetic leases used to finance power plant development at the PG&E NEG (National Energy Group). The review confirmed that payments to the independent equity owners during construction reduced the investor's equity below the minimum requirement to maintain these leases off balance sheet. As a result, the Corporation's statements now include these financings on balance sheet. The change in accounting treatment resulted in no restatement of prior year earnings, a less than $1 million impact on earnings for the fourth quarter 2001, an increase in total assets and liabilities of $118 million in 1999, $861 million in 2000, and $1.058 billion in 2001.
Additional information
Synthetic leases involve the use of a special purpose entity (SPE) who holds title to the asset(s) (in this instance, power plants) and raises the debt to finance the assets. The assets are then leased to a single lessee - here, PG&E. The accounting objective of synthetic leases is to finance the acquisition of an asset and at the same time keep the corresponding debt off the balance sheet of the acquiring company. The SPE typically leases the property to the lessee at rates below those of a traditional lease. Prior to 31 January 2003, the presumption in favour of consolidating an SPE could be avoided if the following two conditions were met:
The independent equity owner in the case of PG&E was an independent third-party lessor.
Required:
Discuss the accounting and ethical issues involved in the case.

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Definitions:

Oil Pollution Act

A law enacted in the United States aimed at preventing and responding to catastrophic oil spills, including the establishment of liabilities and penalties.

Discharges

Refers to the release, disposal, or emission of substances, particularly pollutants into the environment; also can refer to the fulfillment or cancellation of a financial obligation.

Puget Sound

A complex estuarine system of interconnected marine waterways and basins in the northwestern United States, known for its ecological diversity.

Superfund

A federal government program established to fund the cleanup of toxic waste sites.